1. The Traditional Accounting Information System
Chapter 3

2. Objectives
Describe the nature of the traditional accounting cycle and its relationship to business events
Describe the impact of IT on the traditional accounting system
Describe the limitations of the traditional accounting system architecture
Describe how the traditional accounting system architecture limits accounting’s ability to enhance value

3. Pacioli: The Father of Traditional Accounting
Pacioli was not really the inventor, but was “the first accountant to combine his knowledge with the technology that enabled authors to print books using a movable type and a printing press to instruct the world on the subject in print”.
Pacioli documented the double entry, chart of account classification scheme used to record and store accounting data.
To keep the accounts in balance, Pacioli proposed a rigorous process for recording, maintaining, and reporting accounting data. Pacioli suggested the use of three books:
the memorandum book,
the journal and
the ledger.
The memorandum book should include notations of every transaction, large and small, in whatever currency was being used and in as much detail as time and circumstance allowed.
The journal was the source for the ledger, where the double entry bookkeeping was done.
It was in the ledger that the businessman could learn before anyone else whether he was a success or a failure

4. Rules for Accounting
Chart of Accounts See Exhibit 3-1
classify and summarize financial measurements
nominal accounts vs real accounts
One compendium of sample charts of accounts and accounting procedures for different industries is The Encyclopedia of Accounting Systems
Charles Sprague “Any occurrence [accounting transaction] must be either an increase or a decrease of values, and there are three classes of values [assets, liabilities, and equity] ... in every transaction at least two of the occurrences must appear ... on opposite sides of the above list.”
Assets = Liabilities + Owner’s Equity

5. Exhibit 2-1 Sample Chart of Accounts
Account Title
Account
Account Title
Account
Current Assets
Cash 110
Accounts Receivable 130
Allowance for Doubtful Accounts 140
Inventory
Prepaid Insurance 180
Notes Receivable 190
Property, Plant, and Equipment: 200
Land 210
Building 220
Accumulate Depreciation Building 230
Equipment 240
Accumulated Deprec. Equipment 250
Current Liabilities:
Accounts Payable 310
Long-Term Debt:
Bonds Payable 410
Stockholder’s Equity:
Common Stock 510
Capital in Excess 520
Retained Earnings 550
Revenue and Expense Summary 590
Revenue:
Revenue
Interest Revenue 620
Rent Revenue 630
Expenses:
Purchases 710
Freight on Purchases 720
Purchase Returns 730
Selling Expenses 740
General and Admin. Expenses 750
Interest Expense 760
Extraordinary Loss (pretax) 770

6. Exhibit 3-2: Steps in the Accounting Cycle and Their Objectives
During the accounting period

7. Exhibit 3-2: Steps in the Accounting Cycle and Their Objectives
At the end of the accounting period

8. Exhibit 3-2: Steps in the Accounting Cycle and Their Objectives
At the beginning of the next accounting period

9. Accounting Cycle Process
Financial
statements
and notes
Audit
Business
event
Nonfinancial
systems
Information
customers
Accounting Cycle Process
Analyze
business
event data
Ignore
event
data
Financial
statement
notes
Prepare
statements
and notes
Ledgers
Post journal
data to the
ledger
Trial
balance
Prepare and
adjust the
trial balance
Journals
Record
transaction
data
Correct and
adjust
Irwin/McGraw-Hill
Ó The McGraw-Hill Companies, Inc., 2000

10. Step : Identify Accounting Transactions to be Recorded
The purposes of this first step are to identify the business events that can be considered accounting transactions and to collect relevant economic data about those transactions. Accounting transactions are the business events that cause a change in the organization’s assets, liabilities, or owner’s equity. These events include
Exchanges of resources and obligations between the reporting firm and outside parties (reciprocal transfers or non-reciprocal transfers)
Internal Events within the firm that affect its resources or obligations but that do not involve outside parties
Economic and environmental events beyond the control of the company (changes in values)
Accounting transactions are typically accompanied by a source document prepared by someone other than the accountant

11. Step 2 - Journalize Accounting Transaction Data
Measure and record the economic impact of transactions
Transactions are recorded in a journal - Debit, Credit, date, account number, amounts ,and descriptions
General journal and Special Journals
Historical Cost Principle
Posting References and page numbers

12. Step 3: Post Journal Data to Ledgers
The process of transferring transaction data from the journals to the ledger accounts is called posting
General Ledger and Subsidiary Ledgers
Totals of Special Journal Columns are posted
An audit trail should provide the capability to trace an individual transaction from its initial recording all the way through the accounting process to the final figures in the financial statements
Reconciliation is the process of summing the subsidiary ledgers and comparing the total with the balance in the general ledger control account

13. Step 4: Prepare Unadjusted Trial Balance
The unadjusted trial balance is a list of general ledger accounts and their account balances
Convenient method of determining that the sum of the Debit account balances equals the sum of the Credit account balances
If the trail balance does not balance the source of the error must be investigated

14. Exhibit 3-5 Unadjusted Trail Balance Illustrated
Click
to Open

15. Step 5: Journalize and Post Adjusting Entries
Adjusting entries are required when their is no source document to trigger a transaction
Passage of time ( interest or depreciation)
Correct Errors
Record Changes in Estimates
Recording Deferrals
Recording Accruals
Reclassifying balances
Recognizing inventory losses
Source documents from earlier transactions are the primary information sources for adjusting entries.

16. Step 6: Prepare Adjusted Trial Balance
The adjusted trial balance lists all the account balances that will appear in the financial statements (with the exception of retained earnings, which does not yet reflect the current year’s net income and dividends).
The purpose of the adjusted trial balance is to confirm debit-credit equality, taking all Adjusting journal entries into consideration. Confirm Debit Credit Balance
Source for preparation of the Financial Statements

17. Step 7 Prepare Financial Statements
The primary objective of financial accounting is to provide information that is useful to decision-makers. Financial statements can be produced for a period of any duration. However, monthly, quarterly, and annual statements are the most common.
The income statement, retained earnings statement, and balance sheet are prepared directly from the adjusted trial balance.
The temporary account balances are transferred to the income statement, and the permanent account balances are transferred to the balance sheet. FS

18. Step 8 Journalize and Post Closing Entries
Closing entries reduce the temporary accounts (e.g., revenues, expenses, and dividends) to a zero (closed) balance.
Closing entries are recorded in the general journal at the end of the accounting period and are posted to the appropriate ledger accounts.
Permanent accounts are not closed because they carry asset, liability, and owner's equity balances to the next accounting period.
The retained earnings account is the only permanent account involved in the closing process.

19. Step 9 Prepare Post-Closing Trial Balance
A post-closing trial balance lists only the balances of the permanent accounts after the closing process is finished. (The temporary accounts have zero balances.)
This step is taken to check for debit-credit equality after the closing entries are posted.
Firms with a large number of accounts find this a valuable procedure because the chance of error increases with the number of accounts and postings.
The retained earnings account is now stated at the ending balance and is the only permanent account with a balance different from the one shown in the adjusted trial balance.

20. Step 10 Journalize and Post Reversing Entries
At the beginning of the next period, the accountant may prepare and post reversing entries to compensate for the difference in timing between the occurrence of an actual economic reality, and the recording of the economic event in the accounting system.
Reversing entries use the same accounts and amounts as adjusting entries but with the debits and credits reversed.
These entries reverse adjusting entries made at the end of one period and prepare the accounting records for normal processing of business events in the new period.

21. Applying Information Technology to the Accounting Cycle
Human information processing challenges
Human Error
Human inefficiency
Paper based communication is costly
Reasons why IT is not used:
technology does not exist
technology is not cost effective
Using IT to replicate a manual system is not efficient
The accounting architecture needs to be changed

22. Criticisms Of The Traditional Accounting System Architecture
One criticism of the traditional architectures is a lack of integration across functional areas of the organization.
Example: an international computer manufacturer that maintains a separate chart of accounts and ledgers for its manufacturing and marketing divisions because they have different criteria for reporting financial information.
Manufacturing recognizes revenue when a product is shipped to a customer
Marketing recognizes revenue when the customer is billed for the product.
The entire accounting process is automated.
Example:
Two business events
Shipping to customer 8 Journal entries
Billing customer 8 Journal Entries
Adjusting for Revenue Recognition 8 Journal Entries

23. Criticisms of the Traditional Accounting System Architecture
Activities are performed to provide service to the customer
Many systems exist to record and report on activities
Different managers want different views of the data to make decisions in their area of influence
Too many systems

24. Multiple Views of the Same Business Event
Marketing people wants to know about the order to evaluate pricing, plan advertising campaigns, and target selling efforts.
Investors and creditors want to know about all orders to assess the profitability of their investments and the likelihood of a return on their investment
Executive management wants to know about the order to evaluate its impact on the organization
SALE
Personnel view
Production view
Personnel people want to know about the order to pay sales commissions.
Production people want to know about the order to plan production processes
Marketing view
Executive view
Investors and creditors
view (GAAP)

25. The Proliferation of Accounting Subsystems
Business
Event
System A
Edit
Audit
Calculate
Summarize
Stored
Data
System B
Edit
Audit
Calculate
Summarize
Stored
Data
System C
Edit
Audit
Calculate
Summarize
Stored
Data
System D
Edit
Audit
Calculate
Summarize
Stored
Data
Functional
Views
Functional
Views
Functional
Views
Functional
Views

26. Criticisms of Traditional Accounting Systems and Processes
There is a proliferation of often conflicting, nonintegrated systems and subsystems within a single organization.
The architecture captures data about a subset of an organization's business events (the accounting transactions).
Data are not recorded and processed in real-time
The architecture stores and processes only a limited number of characteristics about accounting transactions.
The architecture captures and stores duplicate data in a highly summarized form
The architecture stores financial data to satisfy one primary view (perspective).

27. Architecture of Traditional Accounting
Based primarily on financial reporting:
Income Statement & Balance Sheet
Build new/alternative systems for alternative views of business data.
Confine recorded information to “accounting transactions.”
Store and summarize information in ledgers.
Architecture of Traditional Accounting

28. Accounting Data: A Subset of Business Data
(Limited view &
limited data)
Data that
describes
Business
Activities
Acct.
Data
Business
Activities
Accountants
filter data
General
Ledger
Limited Output
Views / Formats

29. The Heart of the Problem with Traditional Systems
Process: Classifies and summarizes transaction data
Input:
Narrow set of transactions
Output:
Produces narrow functional views
Narrow functional views drive the selection of transactions, classification, and summarization

30. Are These Criticisms Valid?
The criticisms we have presented simply highlight the difficulties of adapting the traditional accounting system architecture to a rapidly changing world.
Today's business world is fast paced, more information intensive, and involves complex business transactions beyond Pacioli's wildest dreams
Today’s information customers are very demanding. They desire a larger variety of faster, customized information products delivered in a variety of modes. For example, many people now want their information system to produce a much broader array of information products such as balanced scorecards.

31. Ways That Accounting Can Enhance Its Value to the Organization
Helping Management Define Business Process Rules - To help management define business process rules presupposes involvement in an organization’s business processes. We should develop an AIS architecture that enables accountants to exercise influence over the development and implementation of business processes rules throughout the business process.
Providing More Useful Information - Traditional accounting measures are expressed almost exclusively in monetary terms: a practice that precludes information on productivity, performance, reliability and other multidimensional data that cannot be easily expressed in monetary terms.
Helping to Embed Real-Time Information Processes into Business Processes - Accountants should provide meaningful, direct input into the design, development, and implementation of real-time information processes that execute business rules and gather business data.

32. Role of the Office of the CFO (Chief Financial Officer)
Insightful contributions into the strategy and planning process
Measures that focus and motivate the organization
Information and analysis that provides insight into how value is being created and how progress is being matched to strategic initiatives.
Leadership of major financial initiatives.
We think objectives such as these provide justification for changing the architecture of any information system that limits the potential of information providers in adding value to an organization.

33. Event-Driven IT Application Overview
Enterprise-wide
Information
Customers
Business
Events
Business
Event
Processor
(business
and
information
processing
rules)
Business
Data
Repository
Reporting
Facility
(Information
processing
rules)
Business
Event
Data
Useful
Information

34. Characteristics of Future Architecture
Based on business events (business activities) rather than information customer views.
Supports business process simplification and change.
Integrates all business data.
Integrates information processes and real-time controls.
Characteristics
of Future
Architecture